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Interest rate rules, endogenous cycles, and chaotic dynamics in open economies
In this paper we present an extensive analysis of the consequences for global equilibrium determinacy of implementing active interest rate rules (i.e. monetary rules where the nominal interest rate responds more than proportionally to changes in inflation) in flexible-price open economies. We show that conditions under which these rules generate aggregate instability by inducing cyclical and chaotic equilibrium dynamics depend on particular characteristics of open economies such as the degree of (trade) openness and the degree of exchange rate pass-through implied by the presence of ...
Fighting against currency depreciation, macroeconomic instability and sudden stops
In this paper we show that, in the aftermath of a currency crisis, a government that adjusts the nominal interest rate in response to domestic currency depreciation can induce aggregate instability in the economy by generating self-fulfilling endogenous cycles. We find that, if a government raises the interest rate proportionally more than an increase in currency depreciation, then it induces selffulfilling cycles that, driven by people?s expectations about depreciation, replicate several of the salient stylized facts of the ?Sudden Stop? phenomenon. These facts include a decline in domestic ...
Interest rate rules and multiple equilibria in the small open economy
In a small open economy model with traded and non-traded goods this paper characterizes conditions under which interest rate rules induce aggregate instability by generating multiple equilibria. These conditions depend not only on how aggressively the rule responds to inflation, but also on the measure of inflation to which the government responds, on the degree of openness of the economy and on the degree of exchange rate pass-through. As an important policy implication, this paper finds that to avoid aggregate instability in the economy the government should implement an aggressive rule ...
PPP rules, macroeconomic (In)stability and learning
Governments in emerging economies have pursued real exchange rate targeting through Purchasing Power Parity (PPP) rules that link the nominal depreciation rate to either the deviation of the real exchange rate from its long run level or to the difference between the domestic and the foreign CPI-inflation rates. In this paper we disentangle the conditions under which these rules may lead to endogenous fluctuations due to self-fulfilling expectations in a small open economy that faces nominal rigidities. We find that besides the specification of the rule, structural parameters such as the share ...